Costco Wholesale (COST -0.12%) posted another phenomenal earnings report for the fiscal second quarter (which ended Feb. 13). Its sales growth is still elevated from pre-pandemic levels despite inflation and supply chain disruptions, and profits soared despite cost and wage increases. How does Costco do it?
Low prices, high sales
Costco operates 828 global warehouses, 572 of which are located in the U.S. It offers some of the lowest prices on the market at razor-thin margins, but it makes up for that on its income statement with its huge volume.
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The company has been posting unusually high sales growth since the pandemic started, and that hasn't stopped. At first it was due to customers hoarding essentials. Now it's due to a confluence of factors, such as customers spending on bigger-ticket items and customers turning to the low-price standby when there's inflation and price increases.
In the second quarter, sales rose more than 16% year-over-year, and comps rose 14%. Earnings per share increased from $2.14 last year to $2.92 this year.
Management is stretching itself to keep prices down as it deals with cost increases in many areas, such as finished products, raw materials, and freight. It has worked out deals with suppliers to absorb some of that, which it can negotiate due to its high volume, and it's absorbing some on its its own. CFO Richard Galanti said on the second-quarter conference call "When asked the question...who's our toughest competitor, it's us."
Creating member loyalty
Costco works with a membership model, and customers pay $60 for a basic membership or $120 for an executive membership for the privilege of shopping at Costco and benefiting from its low markups and prices. Total cardholders increased by 1.7 million from the end of the first quarter to 114.8 million, and membership fees increased nearly 10% year-over-year to $976 million.
Executive members have some extra perks, such as an annual 2% reward, exclusive discounts, and two membership cards. More shoppers opt in every quarter, and these most loyal customers play a significant role in Costco's growth. The company added 644,000 more executive memberships in the second quarter, which now account for nearly 43% of the total, and 71% of total sales.
Costco may be preparing for a membership fee increase in the next year, which it believes it can easily absorb and which will add a significant sum to its coffers. However, it's not ready for that yet. Galanti acknowledged that the company's strategy right now is to add value to its memberships, and it's realizing that goal, and adding revenue, by converting basic memberships to executive memberships.
Chartering its own supply chain
Last quarter, management said it would charter three vessels to ease the supply chain difficulties between the U.S., Canada, and Asia. Now it said it would add four more for a total of seven. These vessels, and containers it's also renting, will affect a quarter of its merchandise, and allow it to circumvent some of the logjams holding up its supply chain. So far it has retained its stock of products, even though some of them are under different labels than it usually markets.
Galanti pointed out that the end of the second quarter is seasonally its highest cash on balance of the year, and cash has built up over the past two years as sales have soared. That gives it leverage to pull these kind of tactics and defend its position from a point of strength, making it hard to compete with.
Costco stock isn't cheap, trading at 45 times trailing 12-month earnings. Investors pay a premium for its reliable growth in any type of economy, and Costco is a no-brainer stock to hold in any type of portfolio.
